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What Did Keynes Explain?

Even if everything Lord Keynes wrote about a capitalist economy is right, Nicholas Wapshott is wrong to write about Keynes that “we owe our understanding of how an economy works to him” (“Was Keynes a Keynesian? In theory.” Sept. 4).

Keynes contributed nothing to that most fundamental analytical tool used by economists still today: supply and demand. (That analysis was fully formed a generation before Keynes wrote.) Not surprisingly, then, Keynes added nothing to our understanding of the vital role of prices in allocating resources. Likewise, he added nothing to our understanding of competition, of the determinants of industrial concentration, or of the function of the entrepreneur. His contribution to international-trade analysis was minimal, as were his additions to our knowledge of economic history and of economic development.

The claim that “we owe our understanding of how an economy works” to Keynes is like saying that we owe our understanding of the way an automobile works to someone who famously explained only why automobiles sometimes run out of gas and what are the consequences of such a misfortune. Even if unassailable in every detail, such an explanation isn’t remotely close to being a “general theory” of how the mechanism in question operates.

Sincerely,
Donald J. Boudreaux

Hayek wrote in 1937 that “before we can explain why people commit mistakes, we must first explain why they should ever be right.” Reasonable people might credit Keynes with better explaining why people commit mistakes, but it is simply absurd to credit Keynes with playing a key role in explaining why and how economies work well enough in the first place ever to break down.

UPDATE (reflecting a comment that I just made to this post): If economics were automotive science, Keynes and the Keynesians can at most be credited with drawing more attention than pre- (or non-) Keynesians gave to the importance of keeping the automobile’s fuel tank filled adequately with gasoline. Yes, adequate fuel is important. The car doesn’t run without it. And Keynes and his followers also offered explanations for why the car’s fuel tank might become dangerously low on gasoline – explanations either regarded as special cases by non-Keynesians, or dismissed by non-Keynesians as wrong.

But even if Keynes’s and his followers’ explanations of why a fuel tank can get too low on fuel, and of what are (some of) the consequences of a fuel tank being too low on fuel, are compelling, such a focus says next to nothing about what makes the engine and transmission work. It says nothing about what the pistons do and how the pistons work in detail; nothing about how the energy produced by the engine is transformed smoothly into the rotation of the tires; nothing about steering; nothing about carbueration; nothing about braking; nothing even, really, about all the details of the mechanics of ensuring that the fuel is fed into the engine at just the right rate.

That is, even if non-Keynesian automotive engineers said too little (or too much that is mistaken) about the importance of keeping the fuel tank adequately filled with appropriately octaned gasoline – and even if everything Keynesians said about why and how the fuel tank can get too low, and about the consequences of its getting too low, is spot-on correct – the analysis offered by Keynes and his apprentice mechanics is not an explanation of how the car works. It’s no “general theory” of automotive engineering.

Not all – not even most – stalled or sputtering or herky-jerky or inadequately powerful automobiles can be fixed simply by adding more fuel to the tank. The problem almost always is something detailed, under the hood, in the ‘micro’mechanics of the engine, transmission, or some other non-fuel-tank part of the car. Simply creaming “add more fuel!” isn’t good automotive science even though there are situations in which adding more fuel is the correct remedy.

Indeed. An explanation focused on the importance of keeping the fuel tank filled with high-octane petrol gives you no insight whatsoever into what’s going on under the hood of the car – and it’s downright mistaken to suggest that the workings beneath the hood of the car can be trusted to go on smoothly as long as the fuel tank remains filled with high-octane petrol.

expatSeptember 5, 2011 at 11:30 am

Question : do your letters ever get published ? (Probably not I imagine).

I suspect that one reason they are not published more frequently, as they ought to be, is that the Journal reserves the big main essays, the “op ed pieces,” for the acknowledged “experts,” and the smaller pieces, the letters, for the small fry, and that the letters of Prof. Boudreaux, clearly a writer of big pieces, encroaches on the territory of the little guys.

That’s just a suspicion, not a fact.

Artemis FowlSeptember 5, 2011 at 11:46 am

I disagree with this one. I think we do stand to thank Keynes for the modern understanding of how the economy works, if “thanks” is the right word. Keynes is in fact responsible for the incredibly wrong-headed way people go about trying to “solve” economic “problems” in this day and age.

PeterSeptember 5, 2011 at 11:54 am

Scott Sumner wasn’t very impressed by Keynes either.

“Hicks (1937) argued that the only thing in the General Theory that was really new was the zero rate trap. Otherwise it was all known to the economists of the 1920s. But Keynes had a big ego, and wanted to claim he had revolutionized macroeconomics, rather than just dress up well known ideas in a different language. So he grossly distorted the actual macro of the 1920s, by creating a fictional “classical” economics where the economy is always at the long run equilibrium. His contemporaries were outraged, but since Keynesian economics won out in the long run, modern textbook writers accepted his version of events.”

I’m sure he understands that equilibrium is never attained, not even in the long run. For, in the real world of ceaseless change, a new equilibrium point is constantly being established before the previous one could be reached. It is only in an imaginary world in which action has ceased and there is no further change that the market reaches the final state of rest and equilibrium.

With merely the notion of equilibrium, but no actual equations, there can be no mathematical operations and mathematical economics. The notion of equilibrium is a starting point for logical but not mathematical analysis.

The “equation of exchange” and mathematical economics imply that the final state of rest and equilibrium is not merely an imaginary but a real state of affairs in which supply/demand relations are unchanging and constant, like those between inert mechanical elements, and from which you could calculate the change in one that a change in another would bring about. And with a socialist dictator deciding what the future should be and technocrats planning for it with mathematical precision, there’d be no more need for the judgment nor profits and losses of entrepreneurs, and Marx, booted out of the house, has slipped back in through the back door of this Keynesian, macro-economic, New Welfare, Neo-Classical, or General Equilibrium Theory.

The New Theorists have never told us where action ended and rest began, and they got the data for their calculations, the constant relations between the magnitudes of supply and demand upon which they based their equations.

They have simply leaped from the premise that the market was imperfect to the conclusion that their dictatorship would be perfect, a leap of faith, not economics.

We must realize too that the debate has crossed “party” lines, that the Keynesian virus has infected and divided even the Austrian School into the pure Austrian faction of Mises and Rothbard and the Keynesian Austrian faction of Selgin, White, Horwitz, Rizzo, O’Driscoll, and Boudreaux, purporting to follow Hayek, but Keynes more than Hayek.

The battle for the Austrian position is being waged not just between the Austrians and Keynesians but among the Austrians themselves.

Don BoudreauxSeptember 5, 2011 at 2:16 pm

Well, I’m happy to be with the scholars – to whom you mysteriously attach the label “Keynesian” – aligned with Selgin, White, Horwitz, et al.

I know you mean well, DG, but your methodology and your understanding of economics is far too cramped – indeed, far too mistaken – to take seriously. You should read less Rothbard and more real scholarship.

vikingvistaSeptember 5, 2011 at 2:52 pm

Whatever your criticisms of Rothbard, it unfair to attribute DG’s nonsense to him.

Don BoudreauxSeptember 5, 2011 at 2:58 pm

Fair enough. But I’ve read too much Rothbard over the years to fail to recognize that his frequent mischaracterization of authors whom (for whatever reason) he wishes to discredit is so skillfully done that he likely misleads well-meaning people into believing that he (Rothbard) has slain a dragon when, in fact, he’s merely slaughtered a straw, fictional devil of his own creation.

The two central tenets of Keynesian “economics,” according to Richard M. Ebeling in Political Economy, Public Policy and Monetary Economics/Ludwig von Mises and the Austrian Tradition, P 204: “the claim that the market economy is inherently unstable and likely to generate prolonged periods of unemployment and underutilized productive capacity, and the argument that governments should take responsibility to counteract these periods of economic depression with the various monetary and fiscal policy tools at their disposal.”

The “pure” Austrian response, that of Mises and Rothbard, is that the depression is entirely the consequence of interference with the market, the market’s reaction to the interference, and its way of purging its consequences and laying the groundwork for recovery.

The Austrian heresy began with Hayek’s agreement with Keynes that the “flight to safety,” though not the primary cause of the downturn, was a secondary cause of it. What should be done about it was another matter. It is my understanding that Hayek would do nothing about it, but would let the market work out its own solution. Not so the Keynesian Austrians, led now by Selgin, who see the “flight to safety” as an “excess demand for money,” and would reinflate the money supply in order to reestablish a “monetary equilibrium.”

While I believe that Hayek was wrong to have agreed with Keynes on that point, I wouldn’t call him a Keynesian Austrian because of it. But I would call Selgin and the others, advocating inflation, by whatever name they choose to call it, Keynesian Austrians. For that is a great departure from the Austrian position and giant step in the direction of the Keynesian position, if not a complete embrace of it. But I haven’t accused them of completely embracing it. I haven’t called them Keynesians in Austrian clothing. I have acknowledged they are ultimate Austrians and only tentative Keynesians by calling them Keynesian Austrians rather than Austrian Keynesians.

In fact Hayek did make some major concessions to Keynesism, but not out of conviction:

From Hayek the Enigma, by Bettina Bien Greaves, a review of Hayek’s Journey: The Mind of Friedrich Hayek, by Alan Ebenstein, Liberty magazine, April 2005, P 49

“In the course of rubbing shoulders with relatively mainstream economists in England and the United States, Hayek had become ‘considerably more integrated with the rest of economic academia, at least with respect to practical policy and personal comity…While he did not backtrack from his fundamental analyses, he countenanced and even advocated that activist monetary policies could be appropriate policy and that even public works might have a role to play in evening out the vagaries of the business cycle’…In ‘The Road to Serfdom,’ he even advocated ‘a comprehensive system of social insurance.’ When Leonard Read, president of the Foundation for Economic Education, questioned him about this, Hayek’s response was, as relayed to me by Read: ‘I didn’t want to be thought a complete kook.’ The phrasing was undoubtedly Read’s; Hayek’s language was more formal.”

“Keynes and Hayek…were in agreement that the increase in money demand, the “scramble for liquidity,” was a secondary aspect of the downturn but in disagreement about what the primary aspect was.”

What does that mean to say it was an aspect of the downturn? Does that mean it was a secondary cause?

Maybe not. Maybe Hayek was not as guilty of agreement with Keynes as I had thought.

But what the Keynesian Austrians don’t understand is that the increase in the demand for money and consequent deflation was not a part of the problem but only of the solution.

SweetLibertySeptember 5, 2011 at 6:07 pm

I would appreciate it if Don or vikingvista could elaborate on where DG is wrong here. It sounds like a reasonable analysis of Keynes vs. Austrian economics to me. Is Don indeed pro Quantative Easing? I didn’t think he was.

You can forget about Viking. He’s a member of the Greg Webb School of Logic.

He thinks I misrepresented Mises and Rothbard because I relied on what they actually wrote rather than what he, a mind-reader, apparently, knew was really in their minds. And of course that means that Mises and Rothbard misrepresented Mises and Rothbard too, and that we’re all duplicitious if we rely on what anyone actually wrote rather than what Viking tells us was really in their minds.

As for Don, he has defended Selgin, so I would assume that he agrees with him, and Selgin is certainly a “monetary accomodationist. ”

Also, Don defended mathematical economics against me, and invoked the “equation of exchange” as an example of it.

Any real Austrian knows that there are no equations in economics, that their conception depends on the Keynesian assumption that the final state of rest and equilibirum is an actual realizable state of affairs, rather than merely a theoretical construct.

Don is the modern Bastiat, but I’m sure he’ll agree that he is no Rothbard.

State control of economic activities is what happens if your country’s name is Germany or Italy and you have a minor event like WWI, hyperinflation, depression and WWII going on. Human action came out in 1949 so doubt that history was unknown to him.

Here’s the full quote:

“The Fascist Government clung first to the same principles of economic policies which all not outright socialist governments
have adopted in our day, interventionism. Then later it turned step
by step toward the German system of socialism, i.e., all-round state control of economic activities.”

I’m not claiming Mises loved fascism or anything like it, but this game of dueling out of context quotes is just that, a game.

JoshINHBSeptember 5, 2011 at 11:00 pm

I’m not getting your point here.

Mises and Hayek demonstrated how the interventionist path will lead to complete control of the economy because the interventionist policies will fail to deliver the intended, promised results at every step, resulting in an escalation of intervention.

The key component is a religious commitment to intervention, after which every failure will be justification for further intervention. This sunk cost mentality manifests itself repeatedly in human affairs including politics.

As you’ve chosen to highlight the point regarding Hayek and Pinochet, I’ll confine my response to that issue:

For your consideration, here three sources I suggest you consult:

1. A posting from Marginal Revolution that explains several facets of the Chilean economy under Pinochet.

2. Pages 250-251 from Johan Norberg’s In Defense of Global Capitalism in which he discusses how Chile came through the Latin American financial crisis in better shape than any of its neighbors precisely because of the reforms ushered in by Pinochet. Reforms that, Norberg corrects goes on to point out, ultimately lead to the downfall of his dictatorship and the ushering in of democracy.

For what it’s worth, I wager that Hayek knew better than most that were Pinochet to be convinced of the benefits of economic liberalization, political liberalization would inevitably follow. In other words, the whole Salon piece is a straw man.

Cheers,
Rob

Greg WebbSeptember 5, 2011 at 1:46 pm

Try critical thinking and you won’t be so easily fooled by such nonsense.

Grow up. This is another example why it’s tough to take your posts seriously.

SweetLibertySeptember 5, 2011 at 1:57 pm

Invisible Backhand,

This article is a great example!

Of how the left deceives.

Here is the Mises quote from your article:

“It cannot be denied that Fascism and similar movements aiming at the establishment of dictatorships are full of the best intentions and that their intervention has, for the moment, saved European civilization. The merit that Fascism has thereby won for itself will live on eternally in history. “

Wow, if left there, you’ve really got libertarians by the balls, don’t you! However, what your author did was cleverly excise with a progressive scalpel these two sentences from the whole. When we follow the rest of what Mises said in the same paragraph, he continues…

“But though its policy has brought salvation for the moment, it is not of the kind which could promise continued success. Fascism was an emergency makeshift. To view it as something more would be a fatal error. (From Ludwig von Mises, Liberalism, section I:10)” (from Sam Bowman, AdamSmith.org)

If you read what Mises says before that paragraph, his views are even more clearly against Fascism.

IB, are you truly succumbing to propaganda and being manipulated here by half-truths and lies? Do you really believe libertarians are for fascism? Do you really believe the things the author said about Milton Friedman and others? Come on, now.

This article is full of intentional deceptions. There may be valid reasons to not agree with all libertarian ideas, but do people like this author really have to resort to bald mischaracterizations in order to demonize their enemy? If so, then liberals should ask themselves why they need this deception to win others to their cause?

Perhaps your parents didn’t tell you, so I’ll leave you with a bit of wisdom Don’t believe everything you read!

Methinks1776September 5, 2011 at 4:36 pm

I couldn’t help noticing almost a week has gone by without a comment about the Salon article on Hayek and Pinochet (among other things).

That excrement has already been dealt with. Your insatiable desire to roll in shit is…smelly.

DaveSeptember 5, 2011 at 1:48 pm

The quote should have been:
“politicians owe their only understanding of how an economy works to him”

Clearly we don’t owe him this because there are so many economist who deny his works. But here we sit with massive amounts of supply dollars ( record corporate profits) that the neoclassicals tells us is ALL that matters ( well until they had to invent regime uncertainty). Yet these dollars are not trickling down into jobs nor an economy of abundance and it is all very very clearly for Keynesian reasons… a lack of demand.

This excellent article and graphic by Robert Reich so clearly explains the history and current state of the American economy from a Keynesian perspective. It does so logically, factually, consistently and predictably.

Then you look for the neoliberal explanations of how we got here and they are wholly inconsistent with the facts. They are left like Zoombie Economist walking dead amongst a sober reality only screaming something about regime uncertainty. You can NOT find a cogent neoliberal explanation that stands up to scrutiny and fits the details as well as Reich’s Keynesian explanation.

So indeed Keynes HAS taught those of us with open minds some very new things about the economy.

The Other TimSeptember 5, 2011 at 2:57 pm

I want to go start a business.

Since regulatory uncertainty is clearly a myth, the uncertainty I have about how to legally do business, what with all these regulations I don’t understand and which are constantly changing, must be something easily dispelled.

Talking points. Your article doesn’t address my personal regulatory uncertainty at all. It should be easy to dispel my concerns. I’ve totaled up the cost of raw materials and labor, now which government office do I call up to get a locked-in quote on the cost of regulatory compliance over, say, the next ten years? Heck, over the next ten months? Novice entrepreneur that I am, even I know that I shouldn’t start a business unless my projected accounts receivable exceed my projected accounts payable.

You do realize that a recovery will require the creation of jobs in businesses which do not as of yet exist, right? That is to say, surveys of the seen businesses do not diagnose the reason the unseen non-businesses are not created.

Or maybe you’re under the deadly misapprehension that all we’re to be concerned about is getting pre-existing business to add more hires. It’s hardly some great insight to note that existing businesses aren’t harmed by the present regulatory scheme. Regulations affect various businesses differently. Those who can adapt to the regulations the best leverage that superiority to prevent competition from entering the market, so as to maximize producer surplus at the expense of labor and consumer alike. It’s called regulatory capture, and it’s a problem for which libertarians uniquely have any cure.

Like the wide receiver who makes a spectacular touchdown run into the wrong end-zone, you don’t seem to realize whose case you’re strengthening.

brotioSeptember 5, 2011 at 8:43 pm

Like the wide receiver who makes a spectacular touchdown run into the wrong end-zone, you don’t seem to realize whose case you’re strengthening.

Excellent!

The Other TimSeptember 5, 2011 at 10:47 pm

Still waiting on this Muir.

I want to sell an Asian confectionery in Minneapolis. I’m looking through their licenses. I can’t register as a confectionery, because those sell pre-packaged goods, and I’m going to make mine from scratch. Traditionally these are sold from sidewalk carts, but does that mean I’m supposed to look into being a Mobile Food Vehical Vendor, or a Limited Mobile Food Vendor? Or a Food Cart Sidewalk?

I could look into getting a Seasonal Food Permit. Then I could do business for 10 days, and see if it’s a viable business model over a 10 day period before sinking any serious money on the venture. They’re cheaper, and don’t restrict their holders to selling prepackaged foods. Of course, then I have to cook in a commercial kitchen, whereas it’d be far cheaper for me to prepare things at home. But you can’t do that with a Seasonal Food Permit, except as allowed by the Minnesota Pickle Bill!

But no, obviously, it’s aggregate demand separating me from my dango stand. The fact that I have to get permission from the government to start a business has nothing to do with it.

Dan JSeptember 5, 2011 at 3:20 pm

‘underconsumption’, muirgeo! Really! We have already seen the asinine results of theorizing about “underconsumption’ and govt attempts to intervene on it. This foolishness was called the ‘FDR presidency’.
When the rules and taxes levied are due to shift, dramatically and regularly, such as Dodd/Frank, Obamacare, EPA, etc.,… And taxes to be increased in a year and a half, there is too much volatility from the federal govt for businesses to work with. Much is the same with individual citizens. Too much volatility from govt interventions. Thee biggest obstacle to recovery and the ‘idle’ dollars working is govt threats of increased costs of operations.
According to Obama and his appointees in EPA energy prices ‘must necessarily skyrocket’. Therefore, I refuse to spend more in anticipation of govt intentionally trying to make my life harder with skyrocketing bills.
Ergo, Obama is the enemy of my finances.

Dan JSeptember 5, 2011 at 3:28 pm

From FDR we got prolonged and worsened misery. We got institutionalized racism with the minimum wage. We got price controls which led to nationwide shortages. We got wage controls contributing to unemployment and a quicker rate of mechanization ( not so bad for future but harmful to those at the time).
FDR was a dick.

Oh yeah because we didn’t prosper through the 40′s, 50′s and 60′s… yeah… those were some real tough years. And things were so miserable with FDR that’s why he couldn’t get re-elected… oh wait… you got nothing.

SweetLibertySeptember 5, 2011 at 6:12 pm

So your argument…

Great Depression: High GDP = Prosperity?
After Great Depression: High GDP = Prosperity!

Wow, how could I not see that!!!

It is you who have nothing.

The Other TimSeptember 5, 2011 at 6:18 pm

If you seriously want to argue that things weren’t miserable under FDR or that the 40′s were a period of prosperity, you have a perverse definition of words.

A significantly more believable reason why FDR kept getting re-elected was that the 30′s were globally characterized by a backlash against liberty wherein scared people turned towards strong men to save them. We have some fairly strong continental evidence for this model.

The Germans and Italians would like to have a word with you about your presumption that populist support is indicative of good policy.

cmprostreetSeptember 7, 2011 at 7:56 pm

Muirgeo, like so many Keynesians, believes that a higher value for Y is an end in itself- that higher Y equals prosperity.

However, E represents stuff that we send overseas. G represents all sorts of things, some of which are tanks and bullets. I represents capital investments made by businesses so that they can produce more efficiently in the future.

None of those are things we can eat, wear, drive, or live in. Those things are what make up C. What we want is to increase C. Higher C equals higher prosperity, with the caveat that E and I may be necessary to keep future C sufficiently high. G detracts from C both immediately and in the future, though it does contribute to Y. This is why statists of all stripes will attempt to divert your attention to Y.

All else equal, higher Y means higher C. However, when you advocate increasing G, I, and E to increase Y and then claim that the increased Y means higher C, you either don’t understand what you’re talking about, or are trying to make sure no one else does. I believe Muirgeo falls in the former category.

Dan JSeptember 5, 2011 at 7:59 pm

I’m going to ask a few 80 and 90 yr olds how great the 30′s were.
When I go from $1 to $1.08, things are not much better.

Grab a mirror. To Expound on great works of FDR shows you have not really looked into what transpired under his regime. The policies sound good and you have looked for something, anything, to leach onto for a positive side to the corruption and filth that was the FDR administration.

Yeah and while your at it ask them if they’d like their social security and medicare taken away. Then show us pictures of the cane lumps on your big fat head.

Dan JSeptember 6, 2011 at 1:06 am

And, I will ask them if they and their sons fought in wars for collectivism, a.k.a. Communism or socialism, and I am sure they would look to club socialists. Haven’t met a senior yet who would side with socialists. They only want back what was taken from them. TAKEN!!!

ccresciSeptember 6, 2011 at 12:36 am

According to Reich’s analysis income inequality reached a trough in the late 70s. What was the quality of life in the late 70s? I believe the term was “malaise”. Additionally, the most effective means of lowering income inequality according to the chart is to have a depression. If anything, given the way Reich divides the data points, Bretton-Woods seems to be the common denominator in lowering income inequality.

Look there is nothing wrong with Keyens’ theories. They just haven’t been tried! Well, they have been tried but, they haven’t been tried by the right people! Well, sure some good people tried them, but they were not tried long enough! And, and, not enough money was spent!!

And the evil capitalists were not cooperating. And the average people were not cooperating!!

But there is nothing wrong with the theory!!!!

Dan JSeptember 5, 2011 at 3:24 pm

Exactly, Ken!!! The right people were not at the helm and unexpected circumstances such as tsunamis, earthquakes, hurricanes, international insurrections, etc.,… Have occurred, disrupting theory.
But, in early 2009, we were supposed to have had the next coming of geniuses, ‘we are who we have been waiting for’, says one Barak Hussein Obama. Narcissism goes deep within the White House.

JimSeptember 6, 2011 at 8:40 am

For many economists and social scientists, no practical flaws uncovered by execution or installment are viewed as valid condemnations of theory. So while your sarcasm may be appropriate to readers like me, you are actually saying exactly what they believe.

I can in some intellectual exercise agree that reality does not affect theory. But that academics are not by now focused on the practical failings of Keynesian policy is beyond me. For there are any number of examples, and they are heroic in their failure.

In fact, rather than arguing the merits of the theory, I believe it would be more fruitful for the other side to challenge Keynesians, using their own theories, to explain its virtually non-existent results.

a_murricunSeptember 5, 2011 at 4:04 pm

To me as a lifelong motorhead (having graduated from 10¢ Superman comics to 25¢ Hot Rod Magazine during the Truman administration), the auto analogy resonated strongly. Simplifying that analogy even more, if your lawn mower won’t start, the first thing you check for is ignition – got spark? Then you *check* for fuel, you don’t just add more on speculation. (Of course, Lord Keynes, being British, may have had no better understanding of electrics than Lucas, the leading vendor of notoriously failure prone electrics in his heyday, the 1930s.) And if you lack one or the other, you must painstakingly diagnose the failing subsystem. You can, of course, vent your frustration with that perverse inanimate object (infinite in number, according to Murphy’s Law) by pouring gasoline on it and setting it afire.

It seems to me that the continuing popularity of Keynsianism is because so many economists and their political patrons have invested so much of their credibility in it.

I had to relearn economics to undo the Keynesianism I was taught in college.

NasSeptember 6, 2011 at 2:08 am

I was discussing this post with a friend this evening, who made an interesting point. What would a Keynsian say about Hayek using the same framework (a car) as a basis for analysis?

My friend claims that Hayek would generally do nothing if the car is ” stalled or sputtering or herky-jerky or inadequately powerful”? Maybe keep turning the key until it starts again? If so, this would basically ensure that the car would never get going again in the minority of cases when all it needed was some more fuel.

Does this seem like a fair depiction? Are we at a point where we will never recognize low aggregate demand when we see it, due to all the regulatory and tax obstructions that we’d need to remove to observe such a phenomenon?

Dan JSeptember 6, 2011 at 2:46 am

Assuming fuel is the problem? And after fuel was added (trillion dollar stimulus, QE1,QE2,etc..) and the car is still sputtering? Add higher octane fuel? Moonshine? Maybe the mechanic put a banana in the tailpipe? Or there were so many speed bumps, stop signs, ethanol requirements that the damn cars insides are all gummed up and there are now broken motor mounts, loose clamps, warped pulleys, need for realignment, loose fuel hose, timing belt broke, worn out head gaskets, etc.,….

NasSeptember 6, 2011 at 10:05 am

Before fuel was added.
When I thought about this further, I realzied if fuel is the problem in a car, you just need a tiny bit and you will immediately know if you were right. In an economy, the amount needed is up for debate, as are the methods used to measure whether or not the fuel caused any difference (how long before you can expect results? how do you tease out the effects of the fuel vs everything else going on?). So this seems to be where the analogy, err, breaks down a bit.

JimSeptember 6, 2011 at 8:42 am

I believe Hayek’s response is akin to imploring the owner to allow the car specialists (mechanics) to fix the car, rather than meddling with it.

NasSeptember 6, 2011 at 10:02 am

What is the equivalent of that in the real world? Let the economists duke it out in the blogosphere? What is actionable in that regime when there is disagreement among the experts?

ccresciSeptember 6, 2011 at 10:50 am

A car is an incorrect framework or analogy and only relates to the monetary aspects of Keynesianism. It is inappropriate because Hayek saw the problem as one of proportionality in that the economy during booms has become grotesque and thus is not producing things people want at the appropriate prices. Thus a better analogy is the economy as a morbidly obese person who wants to be more attractive. The Hayekian response is “Go on a diet and get in shape.” While this response is “do nothing” in the sense that it is all up to the patient the changes and the results are real. Contrast Hayek with the Keynesian response, which is that losing weight will be way too difficult and painful so measures must be taken to give the appearance of proportionality without actually getting rid of the fat. The first part of the Keynesian response is to ensure that the patient does not lose weight by supplementing their normal caloric intake with large “stimulus packages” of sugar because the fat cells will shrink without enough energy. The second part of the Keynesian response is to insert implants into the patient to give the appearance of proportionality. Currently, these take the form of green energy projects, infrastructure banks and regulatory bodies. Given that the Keynesian remedy for economic downturns is based on a flawed understanding of the problem, the characterization of Hayek as “do-nothing” is not only unfair but incorrect. Without government intervention, any doctor who prescribed prolonging the problem as long as possible would soon find themselves out of business.

You stopped your metaphor too soon. If Keynes were talking about automobiles instead of economies, his solution to every problem would be to add more gas. Whenever it didn’t work, his followers would agitate for even more gas to be injected. They’d examine the individual mechanisms not in terms of what they are built to do, but in terms of how they propagate gas through them. They’d add booster injectors all over the car to push gas through more thoroughly.

The metaphor expands to macro-econ in general. Instead of just one variable, gas, the sophisticated macro theorist would add 3-4 more variables such as height, weight, and temperature. The resulting theory would be just as useless when the car breaks down. The car might have corroded spark plugs, but the “mechanics” will be pumping gas into it, refrigerating the car en masse, and putting barbells in the trunk.